Posts from the ‘Medicure (MPH)’ Category

With the acquisition of Apicore, Medicure took on much more debt than they previously had. In order to acquire Apicore they added about $60 million of debt. The debt isn’t cheap, at 9.5% plus 400,000 warrants that they issued for shares at $6.50 (they say in the MD&A that the effective interest rate is 12%). With a market capitalization of $100 million, the additional debt is not inconsequential.

The debt isn’t crippling, but it makes it crucial that Apicore performs in an accretive manner. But from the disclosures provided by Medicure, it’s not clear to me just how accretive Apicore is.

The Apicore deal closed December 1st, 2016, and the one month numbers were excellent, sales of $7.8 million and gross margins of $4.5 million (after adjusting for inventory at the time of the acquisition). But on the conference call the company said that December is by far the strongest month for Apicore and that we should not expect that level of results over the full year. In the financial statement Medicure disclosed that had Apicore been part of Medicure for the full year, net income would have actually been lower, which is a bit worrisome:

On the other hand, in the quarterly presentation Medicure gave color around additional EBITDA from Apicore had they been consolidated for the full year 2016. It is significant (around $6 million). But I don’t know how to reconcile that with lower the net income?

Its not so much that I think that Apicore is going to be dilutive to earnings. I doubt that. It’s just that the company hasn’t made it clear what to expect so it’s difficult to forecast going forward.

The other development that gives me pause is that there has been a move to 2-6hr infusions of Aggrastat. Basically physicians are using Aggrastat for shorter durations. This helps them limit side effects and they are seeing acceptable efficacy. The company described this as a positive development because A. Aggrastat is the only glycoprotein inhibitor (GPI) that has shown efficacy at the shorter infusion time, and B. the reduced side effect profile will lead to usage by physicians previously wary of using GPIs. I quote/paraphrase the comments around this from the call below:

Only about 15-20% of physicians use a GPI. This used to be 75%. The reason for decline is bleeding risk. Because Aggrastat doesn’t have a minimum infusion time, it is better positioned for physicians that don’t use or minimize use of GPIs

While it may end up being positive, I can’t help but think that in the short run this is a headwind for Aggrastat demand. Physicians are going to be using less Aggrastat, that seems like the bottom line here until these other factors catch up.

The final thing that I didn’t love about the disclosures is I found some mistakes in it. For example, on page 25 of their MD&A the total debt does not add up from the constituent pieces. Similarly, on page 24 their operating income isn’t right in their EBITDA reconciliation (though the actual EBITDA end result is fine).

Nevertheless there are positives. With the acquisition of Apicore, Medicure has a number of generics on the horizon that will generate growth.

In March Medicure announced FDA approval for tetrabenazene, which is a generic form of a drug used for Huntington’s disease called Xenazine. Xenazine had over $300 million in sales in 2015, so if the generic can take a decent percentage of that it could be material. They also filed an abbreviated new drug application (ANDA) for a generic in December and have two others in the development stage. In total there are 15 ANDA’s in the pipeline.

So there is quite a bit of potential for growth. But it could still be a number of quarters off. Meanwhile the stock has an enterprise value of over $150 million and trailing EBITDA of $15 million, so it’s not particularly cheap. I do like the growth pipeline though. I’m just not sure at this point, so I took some off.

Portfolio Performance

Top 10 Holdings

See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

Its been a good market for my approach to investing. Volatility is low and the market isn’t really making any big moves. Individual companies are being judged on the merits of their business and the macro picture is taking a back seat.

I believe I have also benefited from being more selective. As I have written previously, I’m taking fewer flyers, being more suspicious of value, staying away from dividend payers and focusing on growing businesses and emerging trends.

As a result these have been the best couple months that I have had in a while.

I made a number of changes around the edges of my portfolio, adding starter positions in a number of names, reducing position size in others, but I remained relatively constant in spirit: I have two large positions: Radcom and Radisys, and a number of small 2-4% positions where I am waiting for a reason to make them bigger.

With respect to my two biggest positions, nothing was said or reported over the last month, including their second quarter results, that deters me in my allocation. I will give a quick synopsis of Radcom’s quarter below. With Radisys I spent a lot of time on them a couple of months ago so I will wait until the next update to say more. In short though, the results were fine, they are engaged with a lot of carriers, they seem extremely confident that those engagements will lead to more deals and we will wait and see what new business the second half brings.

I did add five new positions to my portfolio in the last month. I’m not sure what it was about this month that made it such a boon for ideas. It wasn’t because I worked unusually hard to find them. I just went about my usual process and for some reason kept coming up with interesting stocks.

I’ll talk about 3 of those positions (Bovie Medical, Hudson Technologies and Sientra) in this post. In the interest of space I will leave the other two, Mattersight and CUI Global, for next month. This being an August update I have a lot of earnings news I want to talk about and I don’t want things to go overly long (though I suppose it always goes overly long, so relatively anyways).

With that I will cut-off my general comments and get straight to it, starting with some company updates followed by my new positions.

The press release from AT&T validates the work that Radcom has done, and should make the company the go-to player for other service providers following in AT&T footsteps with ECOMP. I have always felt the big risk with Radcom was the execution of such their large and cutting-edge deployment with AT&T and that something went off the rails. That seems off the table now.

As an aside, I found this webinar, which includes a description by AT&T of what they are trying to accomplish with ECOMP, to be quite useful in trying to understand the platform.

While the second quarter results were inline, on the conference call Radcom’s CEO Yaron Ravkaie made a number of bullish comments. He said that Radcom was now in discussions with 9 carriers, up from 5 in the first quarter, and that the earlier discussions had progressed positively, with feedback coming back from carriers that “this is exactly what we need and we want to progress with it”.

Interesting new opportunities are also opening up. Radcom has soft launched a new adjacent product to MaveriQ that Ravkaie called a “very important component of NFV implementation”. I am assuming this was a joint effort with AT&T to some degree since the product is already being used by AT&T even though they have only started marketing it to other carriers.

A final interesting comment was made at the end of the call when Ravkaie referred to a Tier 1 carrier that was recently in their office in Tel Aviv, their “head of their NFV program spend hours with them”, he went “deep into their NFV strategy” and was interested in “partnering” and “co-creation of cutting edge stuff”.

The negative with the story is timing; we don’t know when the next deal signs and telecom providers are notoriously slow footed. I felt like Ravkaie was cautious about timing, making the following comment on the second quarter call:

the next coming quarters is going to change some of these into deals, and again I can’t really comment on when it’s going to happen, and on exactly when is the next order is going to come in, because everything is so new, so it’s hard to predict. And because as of the end of the day, big solutions in the telecom’s environment, so it does take time

Nevertheless it remains a great story. The stock has moved up strongly since earnings. I’m not sure where it goes in the short run, it all depends on the “when” with the next deal, but I see no reason to believe they won’t get that next deal done at some point.

Willdan looks good

The single sentence story on Willdan is that the company had very strong second quarter results, beat estimates significantly, guided higher for the year, said on the conference call that they have signed contracts that will be deployed in 2017 that they just can’t announce yet, said that revenue in 2017 will show further sequential growth, and said that their micro-grid strategy is taking hold with “increasing evidence to suggest that overall spending on microgrids will increase significantly in the coming years and we are well positioned to capitalize on this emerging market opportunity.”

Willdan reminds me of Argan, which was a little engineering, procurement and construction company that I found on the Greenblatt Magic Formula list back in 2011 (I just checked and its still there!) when the stock was $8. I bought the stock but sold it a few months later at $14. Argan continued to run from single digits to almost $50 now on the back of successful growth of their engineering services.

Argan demonstrates how engineering services can be very profitable if you have a team of the right professionals and you are delivering a service along the right trend. I have said before that I think that we are on the cusp of changes to the power grid that will mirror what we saw first in computing and storage (ala the advent of the datacenter) and currently in telecom service providers (which is why Radcom and Radisys are my biggest positions). If I am right about that Willdan is positioning itself to be in the middle of the build-out.

Oclaro was fine but Infinera made it a bit of a debacle

Oclaro had an excellent quarter, beating estimates and putting out strong growth guidance which was good news. Unfortunately I only held about half the position that I had only a few days before.

I got turned around by a report out of Needham entitled “Optical Super Cycle”. I don’t get Needham research, but I caught wind of a report they had in mid-July that described an optical upgrade super-cycle and managed to get my hands on it. Its compelling; the explosion of data is causing metro, long-haul and data-center interconnect to require upgrades simultaneously.

Its exactly the reason I am in Oclaro. But after being convinced by Needham, I felt like I needed more. So I went with one of their recommendations, a company called Infinera that seemed to be well positioned in long-haul, had the ability to take market share in metro, and wasn’t expensive compared to its peers. No problem right?

Well Infinera announced results three days later and gave probably the worst guidance I have EVER seen. Ever. The company guided third quarter revenues of $180-$190 million versus Capital IQ consensus of $271 million.

This caused a couple of things to happen. First I lost a large chunk of my investment in Infinera. Second, it really shook my confidence in Oclaro, which is a much larger investment for me. After some back and forth I decided to cut the position in Oclaro in half.

My reasoning hear was admittedly a bit suspect. Infinera didn’t appear to be a big Oclaro customer. Oclaro has significant business in China, a market where I don’t think Infinera plays at all. The evidence from the call was that much of Infinera’s problems were internal, in particular that they weren’t gaining share in the metro market like they had anticipated and that a recent acquisition wasn’t bearing expected fruits. Nevertheless what Infinera’s disaster highlighted to me is something that I have always worried about with Oclaro; that I will be the last to know when the optical cycle turns, and that these cycles turn quickly.

Well Oclaro announced their results and they were stellar. Both their results and those of some others suggest that the cycle hasn’t turned yet. Oclaro said they expect at least 30% growth in 2017. Gross margins are expected to expand into the mid-30s from the high 20’s they were only a quarter ago. Their 100G transceiver business has doubled in the last year. The company is well positioned with the two vendors in China (Huawei and ZTE) where their growth depends. The stock has continued to go up since, nearly hitting $7 on Friday.

But I can’t add. I’ll stick with my half position but that’s it. The cyclicality scares me, in particular the fact that they don’t really get to pass through price increases even when the cycle is in their favor, so the benefit is all volume and when the cycle ends or when inventory builds they will be smacked. Needham could very well be right and maybe that doesn’t happen for 3+ years. But I haven’t been able to put together enough knowledge to feel really confident about that. So I think I’ll just leave that one as is.

What is going on with BSquare and DataV is interesting

Here is why I added to BSquare. They had a crappy quarter. The stock tanked. The company has a market capitalization of $54 million but subtracting cash the enterprise value is only $27 million. The market has left them for dead but I’m seeing data pointing to how their new DataV product might on the cusp of taking-off.

Right now DataV has one announced customer, a $4.3 million 3 year contract with an industrial company. Because this company is so small, and because DataV has 70% margins, it won’t take many contracts to be meaningful.

In my last blog post I highlighted a career opportunity I read about on the BSquare site. In particular I noted the following language in one of the sales job postings:

Bsquare is investing significantly in marketing demand generation tied to its industry leading DataV IoT platform. Market response has overwhelmed our current sales capacity, and we are looking for proven inside sales dynamos to join our team

I thought that was pretty positive. Last week I went and looked at the job postings again. There were a bunch of new one’s for android developers but also I found they updated the posting I referenced before, (its here) with the following additional language about responsibilities:

Responsible for making 30-70+ outbound calls (including follow up) per day to inbound leads

I don’t know if this is saying what it reads, but an inbound lead should be a company that has first contacted BSquare, so 30-70+ calls to those leads is an awful lot. Are they exaggerating? Or is there that much interest in the product?

They also quietly published this interview on their website, describing the integration of DataV with a heavy-duty truck environment. Whats confusing about this is that there was a question on the first quarter call that suggested to me that the one DataV customer they had was VF Corp, which is not a trucking or industrial company.

The company has like zero following. There were no questions at all on the last conference call. The only intelligent questions I’ve heard in the last few calls is some private investor named Chris Cox who I am presently trying to hunt down (feel free to drop me a line if you read this Chris!). I don’t think anyone cares about this name. Maybe there is good reason for that. But maybe not.

RMG Networks – will have to wait another quarter for the inflection

RMGN results were somewhat lackluster, the CEO had said that they would be growing revenues sequentially from here on out on the first quarter call and that didn’t happen. Revenues were flat, the issue was that the international business lagged and some timing of sales issues. In particular it sounded like the Middle East was down a lot sequentially.

So it wasn’t a great press release but the color on the call was very positive. In a separate news release they said they had a sales agreement with Manhattan Associates and gave further color on that relationship on the call. RMG Networks had previously been something called a bronze partner with Manhattan which meant they would be recommended by sales if it came up but there was no compensation to the sales staff for any sales they created. The new agreement integrates them into the selling package, most importantly now is that sales gets commission on the RMG products that they sell. Because the products are complimentary this is expected to drive sales. Manhattan Associates is a supply chain solution company so the partnership is right in line with what RMGN is trying to expand into and is also a $4B company so much bigger than RMGN.

They also said they have similar relationships that have been agreed to in principle but are not press releaseable quite yet with two other partners.

The second positive is that the 3 supply chain trials that they have referred to in the previous quarter has progressed into the purchase phase. We should start to see revenues from those in the coming quarters. The CEO gave a lot more color around the sales pipeline and how many leads they are generating and also with respect to the team that they have put together. He really tells a good story, though that can be taken both ways I guess. He is bringing people aboard that the market likes, signing agreements and getting their foot in the door where needed so I am inclined to believe this is just a waiting game to see how it translates into revenues in coming quarters.

Medicure has lots of catalysts, have to wait for them to materialize

As for Medicure, results again were probably a bit weak, I would have liked to see revenue at $8 million but $7.7 million is still pretty strong. The bottom line was hurt by a large stock option expense, and they price their options as awarded so it all hits in a single quarter, you don’t get the spreading out of the option effect that most companies see.

Overall the idea is still there, they are continuing to gain market share with Aggrastat, hospital bags purchased increased 16% sequentially, the company said that June was their highest sales quarter since December and in a response to one of the questions on the Q&A they implied that the disconnect between sales and scripts should resolve itself into high sales, likely in the third quarter.

They are on-track to hear back from the FDA with respect to the bolus vial in the second half of the year, and the Complete Response they got from the FDA back in June for the STEMI indication sounds rectifiable. They said there were 7 concerns that FDA had identified, 6 have been addressed and agreed to by the FDA and the seventh they have sent in their modification and are awaiting the response.

They also provided some color on Apicore. It sounds like they expect to plan to purchase the other 95% of the company, said that Apicore continues to grow over and above the $25 million of revenue they generated last year, and they have a new cardiovascular generic that they are developing along with Apicore that they expect to submit. They were asked again about the price for their purchase option on Apicore and they again said they wouldn’t disclose, which is unfortunate. They commented that they have built out their sales and administrative staff in response to the higher Aggrastat demand and it now has the ability to support multiple products. In particular they can add this new generic with no additional staff increase. They are also on the hunt for acquisitions of other drugs that are complimentary and low risk.

Vicor was Disappointing

I was disappointed in the second quarter results from Vicor given the expectation they had set the last quarter. Much of Vicor’s backlog depends on a server standard called VR13. The new server standard is in turn dependent on a new Skylake chipset being delivered by Intel and the chipset has been delayed (again), this time until the second half of 2017.

The consequence is that rather than orders beginning to ramp beginning in the second half, they likely won’t start receiving order for another 6 months.

I reduced my position on the news. The company still is a technology leader and they still have the best power conversion solution for the next generation of datacenters, but six months is a long time and I’m betting I can build back the position at lower prices.

As I do continue to hold Vicor, I’ll be sure to follow Intel more closely to see where they are at with the chipset. In the mean time the best Vicor can hope for is to tread water.

New Position: Bovie Medical

I came across Bovie Medical doing a scan of 52-week highs on barchart.com. This is a scan I like to do as much as possible during earnings season; you can catch stocks that are starting their next leg up because of recently released results.

Unfortunately I was on vacation at the time and so I caught Bovie a little later than I might have otherwise. I bought the stock at $2.60, which was a couple of days after they had announced earnings. That was up from $2.05, which is what it had opened at the day of their earnings announcement.

Bovie Medical operates in 3 segments:

The “core business” is made up of electrosurgical medical devices (desiccators, generators, electrodes, electrosurgical pencils and lights) and cauteries. This segment makes up largest percentage of revenues and has flat to low single digit growth historically. Bovie has said they want to grow the business at mid-single digits which they were able to accomplish in the first half of this year.

The OEM business segment manufactures electro-surgical generators for other medical device companies. It generated $1.6 million of revenue in the second quarter, up from $941,00 in Q1 and $648,000 in Q2 2015.

The growth from the OEM segment this year was somewhat unexpected. It was partially due to contract restructuring that staggered contracts – they said that contracts are typically front-end development, back end production so they staggered the contracts to even out the revenue. The company did say after the second quarter that the expected the growth rate to slow in the second half of the year but still show growth. From the Q2 conference call comments:

…second quarter performance benefited from purchase orders signed last year and several new contracts were signed in the second quarter that should contribute to revenue growth over the next several quarters.

So the OEM business is posting some interesting numbers but the real reason I bought the stock is a new product called J-Plasma that Bovie recently developed. J-Plasma is a tool that improves the outcomes of surgeries through an ionized helium stream of plasma. The result is better precision and coagulation without significant heating of the tissue.

The J-Plasma system consists of a helium plasma generator and tool disposable. Here’s a screen cap of the disposable tool just to get an idea of what it looks like.

The generator (called the ICON GS plasma system) ionizes helium and produces a thin beam of the ionized gas. You use the beam for cutting, coagulating or ablating the soft tissue. The disposable is the hand piece for delivering the ionized gas stream. It sounds like you replace the disposable with nearly every surgery. There are different disposable hand pieces offered depending on the surgery being performed. The procedure can be used on delicate tissues like fallopian tubes, ureters, the esophagus, ovaries, bowels and lymph nodes.

The initial generator purchase is in the $20,000 range, and the hand tools average $375. Bovie said on its second quarter call that they are shifting to a pay per use option with a leasing program to bypass the upfront capital expense of the generator.

The success of J-Plasma didn’t happen immediately. The company has had the product on the market since January 2015. For the first year growth was in fits and starts. In particular, the capital required from the up-front generator was a stumbling block. The company said the following about the slow progress as recently as the fourth quarter conference call:

The operating metrics and leading indicators for J-Plasma product adoption were strong in the fourth quarter, but sales were below our expectations. We continue to face an exceedingly slow pace of J-Plasma generator sales. While we know that the long sales cycle for capital equipment is an industry wide issue, we also know that our VAC approval track record has been outstanding at over 92%, which makes this situation even more frustrating.

The company is targeting two verticals. They are currently selling J-Plasma into gynecology (estimated total addressable market, or TAM, of $2 billion) and are moving into the plastic surgery business (estimated TAM of $440 million).

There are a number of other markets they can expand into including cardiology, urology, oncology and ENT.

There is also the opportunity for the J-Plasma system to be used in robotic surgeries. Bovie has an expert in robotic surgeries on their medical advisory board that has begun to use J-Plasma in trials. Results are expected in the first half of next year, Bovie is also developing an extension to the product, due to be out in 2017, that will integrate into existing robotic surgical systems. They said on the second quarter call that they are exploring relationships with “existing and emerging surgical robotic systems”.

Sales of J-Plasma increased substantially in the second quarter. J-Plasma sales were $766,000. This was up from sales of J-Plasma of $356,000 in the first quarter, which was up from $284,000 in the first quarter of 2015.

The company made a couple of moves in the second quarter that should increase exposure of the product further. On the second quarter call they announced sales partnerships with two large distributors: Hologix (developer, manufacturer and supplier of premium diagnostic and surgical products) which will add them to their GYN and GYN Surgical line of products ($300mm line), and Arteriocyte, which will start selling J-Plasma to their network of plastic surgeons.

Given that Bovie’s sales force currently consists of a mere 16 employees and 30 independent sales reps, this should increase the reach significantly. The company said that the two agreements are going to expand their salesforce “by multiples”.

One thing I like about Bovie is that they have a small revenue base to grow from. In the second quarter revenue was $9.2 million. This is up from revenue of $7.2 million in the first quarter.

Even though J-Plasma revenue remains in its infancy, incremental growth is still quite accretive to the top line because of the simple math that comes along with the company not being very big.

So we will see how things go in the upcoming quarters. The one negative of note is when I model the growth out to next year, the company is still only borderline profitable after assuming a similar sales pace to the last couple of quarters. So we may be a ways away from a real earnings inflection. Nevertheless, I’m not sure that will matter much if J-Plasma sales can continue at the pace they are at. If they do, profitability is an eventual inevitability and that is what the market will focus on.

New Position: Hudson Technologies

In an unfortunate turn of events I was listening to the Hudson Technologies presentation at the ROTH conference (the presentation is no longer available but I could send a copy I made if someone wants it) on my bike ride home a few weeks ago. I was thinking wow, this sounds like a really interesting idea. So I get home, take a look at the chart and boom! The stock had jumped from like $3.50 to $5 that very day.

Sigh.

Nevertheless I continued to dig and found that in some ways the stock is actually a better idea now than it was pre-spike.

Hudson is the biggest refrigerant reclaimer in the United States. The stock jumped on July 18th (the day of my bike ride) because of the announcement of a contract with the department of Defence:

[Hudson] has been awarded, as prime contractor, a five-year contract including a five-year renewal option, by the United States Defense Logistics Agency (“DLA”) with an estimated maximum value over the term of the agreement of $400 million in sales to the Department of Defense. The fixed price contract is for the management and supply of refrigerants, compressed gases, cylinders and related items to US Military Commands and Installations, Federal civilian agencies and Foreign Militaries. Primary users include the US Army, Navy, Air Force, Marine Corps and Coast Guard.

So this is a big deal for a little company. But it wasn’t the primary reason I was looking at the stock. The story that intrigued me centered around their reclamation of R-22 refrigerant volumes.

R-22 refrigerant, also known as HCFC, is an ozone depleting substance, much like the CFC refrigerant that we all remember from the 1990s. In fact, R-22 took the place of CFC’s in many applications. But because R-22 also has an negative environmental impact it was decided by a number of governments t phase the refrigerant out. In the United States, between now and 2019, production of virgin R-22 will go to zero, as ruled on by the Environmental Protection Agency.

In October 2014, the EPA announced its final phasedown schedule regarding the production and importation of HCFC-22. The order called for an immediate drop from 51 million pounds allowed in 2014 to 22 million pounds in 2015, 18 million pounds in 2016, 13 million pounds in 2017, 9 million pounds in 2018, and 4 million pounds in 2019. No new or imported R-22 will be allowed in the U.S. on or after Jan. 1, 2020.

With R-22 production being phased out, the remaining source of R-22 will be from reclaimed refrigerant. This is where Hudson comes in as the largest reclaimer in the U.S. Hudson should benefit from the production restrictions as they gain market share as well as benefit from price.

Its price where things get really interesting. Over the time period where CFC’s were phased out the price spiked from $1 per lbs to $30 per lbs.

Already we are seeing the price rise. R-22 ended last year at $10/lbs (up from$7.50), it rose to $12/lbs in the second quarter and prices are currently at $15/lbs. The company said on their second quarter call saying they are “showing signs of further price improvement.”

Hudson benefits directly from the price rise. The company has said that they expect that for every $1/lbs rise in the price, 50c should fall as margin.

The opportunity won’t continue forever, but it appears to me that the runway will be measured in years. While new air conditioning units do not use R-22, the economics of repairs for existing units work in favor of R-22. At the Roth conference the company said the following:

…lets say you want to repair unit outside of your house, has 10lbs of refrigerant, repairs are $2,500, even if refrigerant is $100/lb its $1,000… [in comparison] new unit is going to cost you $8,000

Hudson has a market capitalization of around $165 million and there is about $30 million of debt. The company announced 15c EPS in the second quarter. Keep in mind that this number includes no impact from the department of Defense contract and that R-22 prices have risen another $3 in the third quarter.

I honestly thought the stock was going to take off after the second quarter. While it flew in after hours (and sucked me in for a few more shares) it gave up those gains the next day and actually traded down 10% in the in suing days.

It turns out that company executives sold a bunch of stock over that time. The company released a press release on the 10th saying that various executives had sold 1.1 million shares. That’s a lot of shares for a little company to absorb.

You could of course look at this negatively, but keep in mind that these say executives still hold 20%+ of the company, and so they sold down their positions by about 10%. They’ve waited a long time for some sort of pay day, its hard for me to put too much stock in them cashing in a bit once it comes.

I really like this idea.

It seems to me that R-22 prices have no where to go but up, that upwards trend has already affirmed itself, and the stock really isn’t reflecting this. Nor is it reflecting the full impact of the DoD contract, which should be worth around $40 million in annual revenue at similar to higher margins than the existing business right now. While the stock hasn’t really moved up from my original purchase price so I haven’t been adding much, the size on the high side of what I usually allocate to a new position.

New Position: Sientra

I honestly can’t remember how I came across Sientra. It was probably some sort of screen, but I have no recollection of what I was screening with. I’m not getting enough sleep.

At any rate, I came upon the stock the day before it released earnings, which forced me to do some quick work and decide whether I knew enough to take a position or not.

I took a position on that day only an hour before the close. I tweeted my thought in this tweet (as an aside I’ve decided to try to return to Twitter to comment on my portfolio adds. I feel like I am missing out on a level of feedback that was often useful).

I always wince when I make a decision like this; I’ve been bitten by acting too fast before. Yet what drove me to act quickly was because Sientra seemed like a time sensitive situation.

Here’s the scoop with Sientra. The company sells a breast implant. Their product was approved by the FDA in March 2012. By most accounts it is a better product than those that already on the market from Allergan and Johnson & Johnson. The company was taking market share and sales were increasing. In the first six months of 2015 sales were $26 million, up from $21 million in the comparable period the year before. In the third quarter sales were $13 million, up from $10 million in 2014. Unfortunately the results were overshadowed by manufacturing problems that led to the company taking a $3 million allowance for product returns and suspending further production of the impants.

A few weeks before they announced their 3rd quarterr results the company announced that on October 2nd they had “learned that Brazilian regulatory agencies announced that, as they continue to review the technical compliance related to Good Manufacturing Practices (GMP) of Silimed’s manufacturing facility.”

On October 9th Sientra released a letter that they had sent plastic surgeons regarding the issues with the facility. Sientra relied on a single source manufacturer. The compliance issue caused the company to put a voluntary hold on sales. The stock dropped from over $20 to $10.

Sientra did its best to come clean. They worked with the FDA and hired a third party firm to verify the safety of the product. The company was silent for two months and the stock continued to fall, eventually settling at $3 in December.

On January 8th, in a published letter to doctors, the company announced that they had “submitted all of the third testing data of its products to the FDA. He says that, in the company’s opinion, the results show that all are safe and present no significant risk to patients. If the FDA agrees, then their implants will be back on the market.”

The company said that while their investigation found that there were microscopic levels of particulate matter on the products, that data also revealed that even with well controlled manufacturing processes the presence of microscopic particles is unavoidable, and the level of particles from the shedding of a typical laboratory pad would have more particles than their products.

They started selling their implants again in March. The second quarter was their first full quarter of results. Along with the results the company provided an update on their search for a new manufacturing partner. As I had hoped, they announced a new partner.

Sientra has entered into a services agreement with Vesta, a Lubrizol LifeSciences company and a leading medical device contract manufacturer of silicone products and other medical devices…Under terms of the agreement, Vesta is establishing manufacturing capacity for Sientra and is working with the Company to finalize a long-term supply arrangement for its PMA-approved breast implants. Sientra anticipates that all project milestones will be achieved for the Company to submit a PMA Supplement to the FDA during the first quarter of 2017.

Sales in the second quarter were $6.2 million, which is only about half of the $14.2 million in sales they had the previous year, but still a very successful initial level considering their limited launch. In fact the company has to be very careful about how much product they sell before they get manufacturing back up and running. They do not want to risk another supply disruption.

The response to their return to the market has been positive. The reason I was so interested in getting into the stock sooner rather than later is because management gave a very positive review of how quickly customers were coming back. On the first quarter call by CEO Jeffrey Nugent:

We were removed from the market voluntarily and our primary competitors naturally came in and took over those customers that we were no longer able to serve. So what encourages us, and me particularly, is the relative speed and ease of converting those previous customers to come back from those products that they used as a replacement.

So, I could give you a number of other statistics. We have a very high level of analytics inside the Company. We know exactly who is ordering what. We’re following that on a very detailed basis. But as far as pushback, we’re not seeing much. There are virtually no concerns about the safety issues that were raised and we’ve been able to convince those customers that we have the confidence and are giving them the assurance that we are not going to allow them to go back on backorder.

So customers want the product and the market for growth is there. The breast implant market is large compared to the size of Sientra. I had to do some searching, and most of the numbers are behind expensively priced reports, but I was able to gather that the US implant market is at least $1 billion. Sientra had a revenue run rate of around $50 million before it ran into troubles. It seems that there is plenty of market share left to capture.

The one negative consideration is that this story isn’t going to play itself out in the next couple of months. The company remains supply constrained and are relying on inventory for sales. While the details about the manufacturing partner are great, its going to be a while before they are producing new product. The company said the fourth quarter of 2017, which I believe is probably conservative, but regardless new product is still some time off.

Nevertheless, with a positive response from customers and the path to new product clearing, I suspect we will see the stock move higher as we inch towards that date. My hope is that we eventually get the stock back to the $20 level, where it was before the roof caved in.

What I sold

I reduced my positions in Air Canada, Granite Oil and Intermap. Air Canada and Granite continue to be slow to develop. I did like what I read from Granite’s second quarter earnings release on Friday, and I may add to the position again in the coming days.

Air Canada just continues to lag regardless of what results they post. I’m keeping what amounts to a start position here, but after seeing the stock struggle for the better part of two years even as the business continues to improve, I just don’t know what it will take for a re-valuation to occur.

Intermap just keeps dragging along with no financing in place. I sold a little Intermap in the high 30’s but mostly decided to reduce after lackluster news along with the quarterly results released Friday.

In all three cases there is also the consideration that I have come across a number of new ideas as I discussed above and prefer to make room for them.

I also sold Iconix in mid-July but bought back my position before earnings. However, as I am want to do, I neglected to add back the position in my tracking portfolio and didn’t realize that I had not done so until I reviewed the positions this weekend. So I will add it back Monday morning.

Portfolio Composition

Portfolio Performance

Top 10 Holdings

See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

First some house keeping. RBC’s has added new tools to make it easier to show performance for practice accounts. I’ve maintained my portfolio manually through an excel spreadsheet for the last couple of years because RBC screws up the purchase values on their portfolio holding page and the gain/loss on individual stocks are, at times, ridiculous (my average cost is sometimes negative).

Recreating the results, even after building a visual basic routine to update the month of trades, was quite cumbersome, so I welcome these new tools. At the beginning of the post I showed a list of my top ten holdings and below are all my positions, both are from the new tools.

The only information that is lost in this new format are the position by position gains and losses. While this is unfortunate, its so much less work compared to the process I had to go through before that this is how its going to be.

With that said…

I didn’t purchase any new stock in the last month so this is going to be a bit of a boring update. I’ve be dedicated the space below to a discussion of a few of my larger and/or more interesting positions.

With April/May being an earnings period, there is a lot of information to consume. I had mostly good news from the companies in my portfolio. I’ve tried to stick to names with solid operating momentum, staying away from those that might be turning it around but where good news has yet to trickle out. And that has served me well.

As I have remarked before, my portfolio has been sitting in a holding pattern for the better part of a year. While I am still waiting on a break out from the range, I feel better about the stocks I own than I have for a while. Not all of them will pan out of course, but a few will, and hopefully 1 or 2 will be the multi-baggers that I depend on for out-performance.

Radcom

There is a lot to write about Radcom.

Radcom’s first quarter results were fine. The company had revenue of $6.5 million and generated non-GAAP income of 15 cents per share. Perhaps the only negative about the quarter came out in a subsequent filing, that over $5 million came from their Tier 1 client, AT&T.

For the first time the company provided revenue guidance for the full year, a range of $28-$29.5 million. They said that they were very confident in their ability to achieve this guidance as 80% of it was already secured with contracts. In a later filing they said that 50% of their revenue in 2016 would come from North America.

Putting that together, Radcom is saying that they will generate about $14-$15 million from AT&T, and another $14 million from their existing non-NFV deployment.

Overall this is all as expected to slightly positive. But the quarterly results and guidance don’t begin to tell the whole story here. In fact what is most telling about guidance is what is left out; it does not include any contribution from additional Tier 1 service providers.

The company is actively pursuing additional Tier 1 customers for their virtual probe solution (MaveriQ). They said they are in discussions with carriers from North America, Western Europe and APAC. I’ve heard that the number of Tier 1’s is in the range of a handful.

It was reiterated on the conference call that MaveriQ is well ahead of its peers. Competitors either haven’t rolled out an NFV product, or if they have they don’t have real world implementation on it, and it is still tied to hardware.

We have competitors in the market but to our best understanding and everything that I am hearing from the CSPs and say they enrolled out an NFV product, some are saying that they have – they don’t have real world implementation on it. Some seem to be still in the hardware area and you cannot monitor an NFV network with the equipment, that’s why we believe they were the first mover and we were widening the gap with our competition.

This is inline of what I have gathered from one of the leaders in physical probes, Netscout, who recently said that their first virtual device would not be released until May. I listened to Netscout’s webinar dedicated to NFV where they talked about their virtual probe technology and I was not impressed. It felt like the event was put together to prove that they were in the game.

I note that Mark Gomes wrote the following on Friday, which corroborates with scuttle I had picked up from a different source:

In fact, word is spreading that RDCM’s product (MaveriQ) scored a perfect 100/100 in its lab trials, while the nearest competitor could only manage a 70/100. In other words, RDCM’s technology lead is wide, making them the de facto leader for NFV Service Assurance.

Amdocs provided some color around the cost advantage of virtual probes in this interview. Justin Paul, head of OSS marketing at Amdocs, said the following:

The fixed video network model uses virtual probes instead of physical probes. This is because traditional, physical probes can’t probe a virtual network and the cost of a virtual probe is significantly lower than a physical one. We’re working with Radcom to implement a vProbe solution with a North American CSP and we’re seeing from the work we’ve done there that physical probe is 20-25% less costly than a physical probe. In addition, you can throw up a ring of probes around a specific area to address a specific peak in demand and redeploy those licences elsewhere when the peak has passed. They’re cheaper to buy and they offer greater flexibility and agility to operators because of that redeployment capability.

Since the results of the first quarter Radcom announced a share offering. What has followed is an ensuing sell-off in the shares ha culminated Friday when the pricing of the shares came in at a disappointing $11.

Maybe I am too sanguine but I am not worried about the sell-off and while the dilution is unfortunate it is not overly material compared to the eventual upside.

Whether Radcom did a poor job selling their story, were poor negotiators, or just deemed the institutional backing and analyst coverage as being worth the cost of dilution at a somewhat low-ball price is unclear to me.

In the same article I quote above Gomes commented about over-subscription. I have heard similar comments from another source. The price action on Friday where the stock traded enormous volume and did not dip below the offer price suggests significant demand even as some shareholders throw in their cards in frustration after what could be perceived as a poor deal.

So the evidence is that the offer price is not a function of lack of interest and not a reflection on investor enthusiasm for their business prospects or for the strength of their MaveriQ solution. And that was the real negative here; does $11 reflect poorly on Radcom’s business? If it does not, and is a function of their willingness to concede in order to improve their balance sheet and get institutional support then really its not very negative at all.

I added to my position in the days leading up to the pricing. That’s unfortunate. I could have gotten those shares lower on Friday. But I do not see any reason to back track on those purchases.

I sat on a 1-2% position with Radcom for a couple years, all along thinking that this was an interesting little company with a promising technology that was worth keeping close tabs on in case they were able to step into the big time. That is exactly what they’ve done with AT&T and are on the cusp of doing with other Tier 1’s. I would be want not to do exactly what I anticipated doing in the event of such a progression. And in the long-run I don’t think I will care too much that I bought the stock a day or two too soon.

Radisys

The first quarter results marked another step along the trajectory towards transforming Radisys’s business. The company continues to add to its suite products and services designed to facilitate the migration of service providers towards virtualizing their networks.

The company hit the high end of their guidance and then raised their guidance for the rest of the year. They raised revenue to the range of $195-$215 million from $180-$200 million previously. They left earnings per share guidance with the range of 22-28 cents on the expectation that additional costs would be incurred to support the expected revenue ramp.

he guidance raise was in large part due to the new DCEngine product.

DCEngine is a rack frame pre-installed with open-architecture software and white box hardware. Its designed to be an alternative to the “locked in architecture” sold by the incumbent providers, and is consistent with the move to virtualize network functions (as opposed to tying them to hardware) so that upgrades, additional capacity and new functionality can be installed via software installs rather than hardware swaps.

DCEngine had its first order from Verizon, a $19 million order, at the end of the fourth quarter and this order was fulfilled in Q1. On the first quarter call the company said the order from this service provider was expanded to $50 million, with the rest of the order expected to occur in the second quarter.

While this a large order for a company Radisys size, what is most interesting is that Brian Bronson, the CEO, referred to it as a “rounding error” in comparison to what Verizon needs to build out.

DCEngine is a low margin product, somewhere south of 20% gross margins. But volumes could be significant, and management said that once the product gains traction that DCEngine orders “should be in the hundreds of millions.”

In addition, there is ancillary revenue to be gained from DCEngine sales. Right now Radisys populates each rack with two white box switches. In the second half of 2016 the company’s FlowEngine product will be upgraded and allow Radisys to replace those switches with it. FlowEngine is a 60%+ gross margin product.

Second, the move from central office to data center is complicated and often requires support services from Radisys. Providing the rack positions Radisys as the natural support resource, which on the call the company said can add another 10 points of operating income.

The company painted a positive picture of growth going forward.

They said that in addition to the Verizon order they were in discussions with a dozen service providers for DCEngine and expect to have 4 to 6 in trials by the end of the year.

With MediaEngine Radisys continues to ship product to their Asian servicer provider customer and said they are “increasingly confident in our ability to secure further orders.”

They also see strong orders for FlowEngine in the first half from their Tier 1 carrier and while that might taper off somewhat in the second half they are still expecting revenues for FlowEngine to double year over year and there is the opportunity that more orders will materialize in the second half.

There are a lot of evolving parts with Radisys which make it difficult to pinpoint a forecast. If I assume that revenue can grow 10% in 2017 on top of midpoint of guidance growth in 2016, that gross margins stay constant and SG&A and R&D costs increase modestly, I easily get to an EPS above 40c in 2017. This seems like pretty conservative projections and yet it should easily support a stock price that is 50% higher.

What is interesting is how sensitive the numbers are to incremental revenue growth. 15% revenue growth produces and EPS above 50c while 20% revenue growth in about 60c.

What this makes clear is that there is real upside if the product suite begins to gain traction and realizes some of the expectations management alluded to one the conference call. The speed of the move up above $4 makes it difficult to pinpoint exactly where one should add to their position, but I feel like somewhere in the low $4’s, high $3’s will look like a good price in the long run.

Medicure

I was pleased with the first quarter results announced by Medicure. Sales were down to $6 million from $9.5 million in the fourth quarter. Earnings per share were 5c again down from the fourth quarter. None of this was unexpected after the run-up in earnings in Q4 due to Integrillin shortages.

Earnings as reported by the company are also being depressed by higher intangible amortization due to Medicure reversing some of the write-down of intangibles related to Aggrastat in the fourth quarter of last year. These intangibles show up in the cost of goods sold (which is why margins were down to 86% in the quarter) and most drug companies exclude them from their adjusted earnings. Without the intangible earnings would have been 8c per share.

As the slide below, from their first quarter presentation, demonstrates, first quarter sales of Aggrastat were down sequentially as wholesalers that had stocked in the fourth quarter due to shortages of Integrillin purchased less but still up from the third quarter.

The company also provided data for hospital bag demand, which was down again from the fourth quarter but to a lessor extent than sales, and up significantly from Q3.

Interestingly, the company gave a couple data points to help investors normalize their sales data. They said that first quarter sales understated demand by “a couple million dollars” because of the destocking. They also said that they are currently shipping 1,700 bags per week, which works out to 20,000 per quarter and means that bag demand has continued to ramp subsequent to the first quarter.

The day before earnings Medicure announced that they are in the process of filing for bolus vial format approval – this will make it easier for hospitals to use Aggrastat. Some hospitals struggle with delivering high dose bolus via intravenous pump instead of syringe. The company provided the following clarification on the conference call:

Although the current bag format can be used to deliver the HDB as well as the maintenance infusion, some physicians and hospital catheterization labs prefer to administer the initial bolus dose with a smaller volume of drug product. Moreover, the availability of a ready-to-use bolus vial will provide greater operational similarities and efficiencies for hospitals transitioning to AGGRASTAT.

Finally, although there is nothing concrete yet, the company reiterated its interest in purchasing Apicore, the generic supplier that they own 5% of, have a purchase option on the remaining interest, and are in partnership with for the production of a as of yet unnamed generic later this year.

There were a couple of questions in my last post about Medicure. In particular what generic Integrillin meant to Aggrastat and second, whether Aggrastat itself would have a generic equivalent soon.

The second question came up because when you look at the patents that Aggrastat has, some of them run out as soon as 2016. While its still not totally clear to me everything I have read suggests that when a drug is approved for a new indication it extends the exclusivity of the drug. Medicure was granted patent until 2023 on the high dose bolus.

I still haven’t found the smoking gun that addresses this type of situation specifically but I did find a number of resources that indicate that generics will not be allowed until the high-bolus patent expires. This link to the FDA describes the periods of exclusivity for various NDAs. This slide show describes how a new drug is patented and how the exclusivity period is determined. This q&a describes how a patent is extended with a label change for a new indication and how that will keep a generic off the market. In the book “Cracking the Code” authors Jim Mellon and Al Chalabi write:

Quite often, drug companies therefore try and extend patent life by tweaking the molecular structure of their drugs, changing the dosages or combining their drugs with other therapies to try and create a novel but similar product that allows the patent life to be extended.

Also worth noting is that Medicure does not refer to generic tirofiban (the drugs name) competition as a risk factor in their AIF.

As for the generic competition from Integrillin, it is real and occurring but Medicure allyed concerns by updating their price competition slide to include the cost of the generic.

Aggrastat remains the cheapest of the bunch.

I have added to my position around the $5 range and even caught a couple purchases in the $4’s. Unless I am wrong about the direct generic competition being years away I think the stock is too cheap and should trade up to a high single digit number on the current level of Aggrastat sales alone. If there is a positive event with Apicore, the new generic introduction, or additional sales from new indications for Aggrastat, then all the better.

Air Canada

I continue to believe that Air Canada is misunderstood. Maybe some day I will be proven right.

The stock trades at a significant discount to all of its peers. The justification behind the discount amounts to:

Air Canada has a lower operating margin

Air Canada has a comparatively higher debt load

Air Canada’s strategy of capacity additions is bound to end in tears

I get that (1) and (2) validate a somewhat lower multiple than a debt free, high margin peer. But the current discount is too much. As for the third justification, I think it fails to recognize what Air Canada is trying to accomplish.

Air Canada is adding capacity, but it is not to serve a slow Canadian economy. Capacity is being added to international flights in what they see as under-utilized Canadian/international hubs in Toronto, Montreal and Vancouver. The strategy is to pin-point international demand where the location of the hub and cost structure puts them at an advantage against the competition.

Air Canada is also taking advantage of what is actually a lower cost structure on some routes (due to Canadian dollar based expenses and new airplanes with better efficiency) to claw back trans-border traffic that they lost to US carriers during the dark period of their bankruptcy and near-bankruptcy.

Finally Air Canada has added new planes and routes that increase their flexibility to redistribute the fleet during slowdowns like the one that we have seen in Alberta. It didn’t seem to get a lot of focus in the first quarter follow-up but the Alberta slowdown barely blemished their results.

I think its instructive that with few exceptions when Air Canada comes up on BNN’s Market Call, the pat responses is:

The Airline industry is always terrible

Air Canada has gone through bankruptcy before

It can’t be different this time

What is unfortunate is that there is no quick fix to this perception. The past couple of years of mostly excellent results are proof that it is going to take time, maybe a full cycle, before portfolio managers become comfortable with the idea that Air Canada has positioned themselves to withstand economic weakness and grow the business in good times. Perhaps when oil prices recover and we see the Canadian economy turn up investors will start to conclude that hey, that was the downturn, and look, Air Canada is still standing. I’m willing to wait that out as long as the company continues to perform.

Health Insurance Innovations

Health Insurance Innovations turned in a very good first quarter but they haven’t gotten a lot of credit for it. Revenue was up 88% to $42.5 million. EBITDA grew from a negligible amount in the first quarter of 2015 to $4.2 million in 2016. Policies in force grew from 195,100 to 258,000 sequentially while submitted applications grew from 153,300 to 192,200. They saw growth from all their sales channels but in particular Agilehealthinsurance.com, their online sales channel, doubled from 11,000 policies submitted in the fourth quarter to 23,000 policies submitted in the first quarter. Both revenue and EPS guidance were increased for the year.

I’m not sure why the stock hasn’t responded better. There is a large short interest, which I don’t really understand, so maybe those players have been doubling down on their bet. The mid point of EPS guidance is 40c, so the stock trades at 15x this years earnings which does not seem expensive given the growth they are beginning to experience. I suspect that comments on the conference call are partially responsible for the muted response. They said their baseline assumption is that growth will level out at Agile until the next open enrollment:

we’re taking a view that says a lot of people bought it during open enrollment that’s why we’re still strong and things are going to level off until the fourth quarter when open enrollment comes in.

Hopefully, we’re wrong and we have dramatic sales in between these open enrollment periods, but frankly given the dynamism of this market, we’re not sure and so we’ve done our best to forecast sales at Agile and the rest of the company over the next six months and that take place in our guidance.

I think this might be conservative. The story seems to be getting better. At the current price the growth trajectory that has began to emerge over the last couple of quarters is not priced in. While something has held the stock down since the release of the first quarter results, I doubt that can continue with the release of another strong quarter.

Shorter thoughts on a few other names

Granite Oil

Granite Oil had their credit line reduced from $80 million to $60 million. While I expected some reduction, this was a bit larger than I had anticipated given that the company has such modest debt levels compared to its peers. Fortunately the company only has $40 million drawn so the reduction is not really an impediment.

Intermap

Intermap still hasn’t received initial payment to allow it to start its SDI contract in the Congo. I never expected this to be easy and I acknowledge that the stock is a flyer so I have it sized accordingly. The bottom line is that the risk reward remains attractive if you treat the position like an option that could expire worthless (or close to it anyways) but also could be a ten bagger. I note that Mark Gomes, who I quoted above, is involved in Intermap as well and has written a number of good posts on the name.

Rentech

Rentech had a not unexpectedly terrible quarter. In the fourth quarter the company was pretty clear that the ramp at Atikokan and Wawa wasn’t going smoothly, needed more equipment, that they were still tweaking operation plan, and that they were not even sure Wawa would reach original capacity. In the first quarter they appeared to get Atikokan on-track which leaves Wawa. Here is what they said about Wawa on the conference call:

Our production shortcomings appear to be the product of limited experience operating the plant at higher levels of throughput and sustained operations as a result of our past conveyor problems. We are now experiencing the operational and production issues that we should have witnessed last year, but for the conveyor problems.

Even with these recent challenges, we’re still learning how to respond to or prevent these causes of production disruption that are typical of ramp-up of new pellet mills, such as sparks, jams, plugging, dust, moisture content, silica content, truck dump outages, hammer mill clogging, et cetera.

On top of that they experienced weather related weakness at NEWP. The warm winter in the North East reduced demand for wood pellets.

I have only taken a small position in the stock and I don’t plan to add more until we see positive momentum from the Canadian operations. But I look at these plants like a mine, which I have quite a bit of experience investing in, and the two things I have learned about starting a new mine is that A. it never goes smoothly and B. the initial start-up problems are typically figured out after some time. So I think Rentech will get their hands around this, and I want to be ready when they do.

Mitel

I sold out of Mitel, at least for now. The acquisition/merger with Polycom takes the company further down the path of being a hardware provider for enterprise telecom solutions, which is not really why I found the stock interesting. The justification around the deal is mostly about cost reductions and synergies, not growth, which again is not inline with my original thesis. And the combined entity still has to compete against Cisco which is significantly larger and has been taking market share from Polycom. Until I get a better understanding of where Mitel is going from here, I thought it best to exit my position.

TG Therapeutics

I bought back into TG Therapeutics at $7 last week. There hasn’t been any negative data to justify the fall in the stock of late. My original investment thesis still stands, just at a price now that is about 2/3 of what it was at the time. Really, if anything we are getting closer to the conclusion of their Phase II and Phase II studies.

By the way, if anyone can recommend any good books for understanding biotechnology please send me an email liverless@hotmail.ca. Thanks!

Portfolio Composition

Click here for the last four weeks of trades. Note that the 224 share AdjIncr transaction is because when Swift pink sheet equity converted to new equity I lost my shares in the practice account and so I had to restore those manually.

Portfolio Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades

Thoughts and Review

I’ve been trying to stick to core ideas over the last four weeks, not taking fliers and taking a very close look before I purchase anything. If you remember, last month I reflected back on the last year, where I really didn’t do all that well, and concluded that my so-so performance could be attributed to too many mistakes with peripheral ideas that I either held too long or should not have gotten into in the first place.

At the same time I’ve been willing to tweak my exposure to stocks up a notch because my two main worries have abated. As I wrote in my February post what worried me was:

The collapse of oil bringing about energy company bankruptcies that a. lead to investor losses that start to domino into broad based selling, and b. lead to bank losses and bond losses that cause overall credit contraction

The collapse of China’s banking system leads to currency devaluation and god knows what else. Kyle Bass wrote a terrifying piece (which I would recommend reading here) about how levered China’s banking system is, how their shadow banking system is hiding the losses, and about how government reserves are not large enough to pacify the situation without a significant currency devaluation.

Both of these events seem off the table, with the first maybe completely eliminated and the second at least postponed.

Still the market is back to that 2,100 level and it is difficult for me to get excited about another move higher. Where I can I have added some index shorts and also some individual tech name shorts to balance in case of a pullback.

Still finding new ideas

Even as I try to be cautious, I still have found a lot of new stocks this month. I added positions in Swift Energy, Clayton Williams Energy, Granite Oil, Medicure, Rentech and Oclaro. It was a busy month and there are lots of stocks written up below. I feel pretty good about all the ideas, with the usual caveat that if oil starts to go south my oil stock positions will be reduced quickly (not Swift though, which is a special situation as I will describe).

Canadian Dollar Doldrums

I’ve had some decent gains in the last month and am back within a a few percent of my highs. But quite honestly my portfolio would be back to its high already if this damn Canadian dollar wasn’t killing me.

About half of my portfolio is in US stocks but as a Canadian I report my gains and losses in Canadian dollars. Lately, every day the market is up the Canadian dollar is up (usually a lot) and because of that a chunk of my gains disappear. To give it perspective: since the beginning of the year the Canadian dollar has gone from about 1.38 US to 1.27. Every $100,000 I had in US dollars was worth $138,000 at the beginning of the year; today its worth $127,000. Its been a headwind.

I’ve been saved by picking some US stocks that have done very well. Radisys continues to be huge. Apigee is a big winner off its lows. Clayton Williams has doubled in a few weeks. Both Iconix Brands and Patriot National have had big runs off their lows. Things would really be rolling if I didn’t have to deduct 10% from the aggregate sums.

Oh well. The Canadian dollar going up means that oil is going up, and living here in Calgary I can tell you that is a good thing. Things are unquestionably slow in the city. If you are in the oil and gas sector, its depressing.

Cowtown Slowdown

As an aside with respect to my home town; I honestly don’t see the Armageddon situation that some have described. I bike past downtown condos every day and while the sun is up so I can’t count the lights, I can count bbq’s and bicycles on the balcony in these supposedly empty apartments. I live in one of the downtown “high-end” neighborhoods where its been said that “every second house is for sale” and yet I see only a smattering of for sale signs and a number of them sold. The restaurants I walk by still seem busy. To be sure, things are slow and if you work downtown in the patch they are miserable, but overall it seems not very different than a year ago. Is this what depression looks like? Or do I just not have the clear perspective of an outsider, what I see being distorted by a home town bias?

Oil move

I’ve given up trying to predict whether this is the real move in oil and if not when that move will come. So just like all the other head fakes, I’ve added positions on the move up with the expectation I can be nimble enough to squeeze out some profits even if this turns out to be another short term blip.

I will repeat what I wrote in September about oil, which could be paraphrased to say “I don’t think anybody really knows”:

But with all that said, I remain neutral in my actions. I’m not going to pound my fist and say the market is wrong. I’m just going to quietly write that I don’t think things are as certain as all the oil pundits write and continue to be ready to pounce when the skies clear enough to show that an alternate thesis is playing out.

With that let’s talk about some stocks because I have a lot to say, starting with two of the three oil stocks I bought (I’ll talk about Clayton Williams at a later date).

Swift Energy

I think this would could be a legitimate 20 bagger if it all pans out. If only I had the confidence to make a Cornwall Capital style bet on it. I tweeted about this last week because I wasn’t sure if I’d be able to mention it in a post before the effective date. Unfortunately that looks to be the case as the stock was halted all day Friday.

Swift is in bankruptcy. At the end of last year they prepackaged a plan with bondholders. That plan has been approved by a judge and the company should be coming out of BK shortly. In the plan existing equity actually does quite well, retaining 4% of the new company shares plus 30% of equity via warrants. The warrants are well out of the money compared to the current pink sheet price. But they are also very long term, with half of them expiring in 2019 and the other half in 2020.

The bankruptcy plan converts ~$900 million of bonds into equity. The company that emerges from bankruptcy will have $325 million of bank debt and, net of cash, somewhere around $250 million of net debt. So the balance sheet is very de-levered compared to the company pre-bankruptcy and also compared to its peers.

The pink sheet implies a market capitalization of around $240 million and an enterprise value of just under $500 million. That means that the market is giving Swift an EV/flowing boe valuation of $16,000. Checking that against the RBC universe, peers trade at between $30K and $100K. On an EV/cf basis, which I again compare off of the RBC price deck for 2016 ($40 oil and $2.50 gas), Swift gets a 5.5x multiple versus 10-20x average for the RBC coverage universe.

As I said the warrants are way out of the money but by my calculations they provide an extremely healthy upside scenario. You get 7.5 warrants per share. Half of those warrants are in the money at ~72 cents, with the other half at ~78 cents. If you get a stock price of 90 cents by 2019 you are looking at nearly a $2 return on your ~20 cents purchase. $1 gets you close to $3 return. See the model below:

Of course a lot has to go right for all this to happen but its a long runway and even at 90 cents you are looking at an EV/flowing boe of around $43K and EV/cf of 15x assuming flat production, $40 oil and $2.50 gas.

The dream scenario is that natural gas prices go up some time between now and 2019. If we hit $4 gas again Swift is going to make a lot of money, and a $2 billion enterprise value is not impossible (would still only be $62,000 per flowing boe on current production). That would give you a 26x return on a 20 cent stock purchase.

On the downside, obviously management is not ideal. Went into downturn with no hedges and way too much debt. Operationally it actually seems like they’ve done pretty well though. And the acreage they own, particularly Fasken, looks like some of the best of the Eagleford.

Granite Oil

This is an oil stock I’ve held in the past and that I bought again after it appeared that oil was going to make a legitimate run. I have added to it in the last week as oil has stayed very firm in the face of some bad news (Doha, Kuwait).

But I’m a bit worried. Granite just doesn’t seem to be performing like it should. Below is a performance comparison I stole from this Investorvillage post:

The problem with investing in any of these Canadian juniors and intermediates is that production data comes out semi-publically through a subscription you pay for via IHS. I of course, do not have access to this data. So there is a chance that some are seeing declines in January and February and getting a head start selling on what will be a weak first quarter.

Granite also hasn’t put out a new presentation since February, which you can construe a few different ways, both positively and negatively.

Granite may also be in the penalty box because the same management team sold out their shareholders when they took an offer for Boulder Energy (of which Granite had split last year) at around $2.50 per share, or about one quarter of what Boulder traded at last year. I imagine there are pre-split shareholders of both names that decided to jettison Granite in disgust after the Boulder news.

Granite currently trades at a $200 million market capitalization and has $40 million debt. In the third quarter they produced 3,476 boe/d. Their valuation is roughly inline with peers, though Granite’s low debt position should allow for some premium in my opinion.

They have proven themselves to be solid operators; in 2015 they “decreased capital costs by 29 percent through the year to $2.0 million per well” and operating costs from $7.50 per boe to $6.00 per boe (source).

What I have always found exciting about Granite is that they have a low-decline and relatively low risk development opportunity applying a gas injection enhanced oil recovery technique on known reserves. But they also have a very large surrounding land position, which allows for a significant expansion of the program if oil prices recover and make them attractive to a larger acquirer. Below is a map from their presentation to give you an idea of their current drilling focus and more importantly the expansive land package that surrounds it:

So I like Granite as a reasonably safe way to play a price recovery. I am optimistic that the poor share price activity is an opportunity and not an omen. The company remains reasonably priced with low debt and is one of the very few oil companies in Canada that can squeak out profitability with oil prices above $40.

Medicure

I got the idea for Medicure from a radio program we have in Canada called Moneytalks. It used to be that Moneytalks was full of gold and silver interviews and end of the world enthusiasts so for a long time I did not make time to listen. But lately Michael Campbell has been interviewing more real managers who have been giving out the odd gem of an idea with Medicure being one that I was enticed to buy.

Medicure was recommended by a PM at Maxam Capital. I found this excerpt on the company in one of Maxam’s recent letters to clients:

Located in Winnipeg Medicure is a small pharmaceutical company with a drug called Aggrastat that prevents thrombosis and is used intervenously in hospitals. Sales of Aggrastat have been growing rapidly since FDA approval first of recommended dosage in 2013 and then an expanded dosage regime in April of 2015.

On top of their ownership of Aggrastat, Medicure also has an option to purchase a growing generic manufacturer in India called Apicore. This is where things get a bit fuzzy. As part of a financing they orchestrated for Apicore in the summer of 2014 Medicure received a 6% interest in Apicore stock and an option to acquire the remaining shares at any time before July 2017. But in a strange twist, the purchase price of the remaining shares of Apicore is undisclosed. I looked all over trying to find an indication of what the option price is, but to no avail. So trying to value the option is a bit of a guessing game.

Medicure gives a small hint in their presentation that it is probably worth more today than it was in the summer of 2014. They provide the following information with respect to Apicore’s sales each of the last 4 years:

Clearly there has been significant revenue growth at Apicore since Medicure was granted the option to purchase the company.

The balance sheet accounting of the Apicore interest doesn’t help much because the only changes Medicure has made to the value of their position is due to currency fluctuations.

Medicure trades at a market capitalization of a little under $90 million. They generated operating cash flow of $7 million in 2015 and do not have significant capital expenditures. Aggrastat is growing and so one should expect increasing cash flow going forward. And then you have Apicore on top of that, which must be worth something, though its not clear what. So adding it all up, it seems that the current price of the stock does not reflect the cash flow generation capacity of Aggrastate let alone the value of the purchase option for Apicore.

Rentech

I got the idea for Rentech from @alex_estebaranz on Twitter. Up until this year Rentech has operated two businesses: the first being wood processing (wood chips and pellets) with operations in Canada and the United States, and the second being fertilizer, with two plants producing nitrogen based fertilizer.

In 2015 the company decided to get out of the fertilizer business in order to reduce debt. In August Rentech sold their East Dubuque fertilizer plant to CVR. They followed this up with the sale of their Pasadena facility in March of this year.

The sale of East Dubuque to CVR was the more significant of the two deals. Rentech received 1.04 units of CVR Partner stock in addition to $2.57 cash. The proceeds have allowed Rentech to pay off about $150 million of debt. Even after the payoff of Rentech retains 7.2 million units of CVR (valued at about $60 million). They have $95 million of cash.

Rentech has 23 million shares outstanding so at $3.30, it holds an $82 million market capitalization. The remaining debt they have is about $136mm. Subtracting what’s left of the CVR units and cash on hand and the enterprise value is low, only about $60 million.

What do you get for $60 million? A wood chip business called Fulghum Fibers, a US wood pellet business and a Canadian wood pellet business. Below was 2015 EBITDA by segment in addition to an EBITDA forecast, which I will talk about shortly.

As you can see the Canadian business is a bit of a mess. They are ramping up new two new facilities and having trouble doing so. It’s costing more money than anticipated, they’ve had to replace equipment and there is some question whether one of the facility can be ramped up to the original capacity expectation.

Nevertheless, even with reduced expectations Rentech expects that these facilities can generate between $13 to $16 million of EBITDA. They sell their pellets to Quebec and Ontario Power for power generation, so they have steady customers for their product.

Rentech has also said they are in the process of taking out $10 million to $12 million out of SG&A.

Basically with the sale of the fertilizer businesses it’s a story about turning around the Canadian business and cutting some costs. If the cost cuts materialize and they can generate the expected EBITDA in Canada, EBITDA can probably touch a number north of $30 million. That would make a $60 million valuation far too low and something at least double that would be more reasonable.

Oclaro

I got the idea for Oclaro from a friend who is always coming up with off the radar ideas. Oclaro makes optical transceivers. The optical transceiver business is not a great business; competition is high and there is always a higher speed device on the horizon to upset any market share gains that you might have scraped together.

You can witness this by taking a look at Oclaro’s gross margins, which tend to hover around the 25% range historically. But Oclaro is on the right side of the cycle right now. The move in the high end of the optical market is towards 100G transceivers, and Oclaro has a leg up in this segment.

In particular there is a large build of long-haul optical in China that Oclaro has been winning business from. They have a contract with China Mobile for 21,000 plus line side 100G long-haul ports. The China Mobile contract is going to be delivered in Q1/Q2. There are also contracts with China Unicom and with China Telecom for 8,000-10,000 ports each so similar size to China Mobile, and these are scheduled for early second half of the year. On top of this there is regional demand from metro China customers that is ramping.

The product wins are leading to a ramp of their 100G production lines:

We will ramp both manufacturing lines for the ACO over this calendar year and we expect to go from shipping hundreds per quarter to thousands per quarter by the end of this year. We continue to believe that the majority of the early demand will be focused on data center interconnect

On their last conference call (second quarter) management made the following interesting comment that demand is exceeding their capacity to build the transceivers:

Our growth in Q3 will not be gated by demand. We’re running very tight on capacity for most of our 100G products, as well as our tunable 10G offerings. As a result, we’re adding significant capacity in all these areas. Our ability to grow will be governed by how quickly our capacity comes online, as well as the capability of some of our piece-part vendors to respond to our increased demand.

In the spreadsheet below I’ve tried to model out what I see happening to Oclaro over the next couple of years and their strong 100G position takes hold. Their fiscal 2016 is half over, with revenues of about $180 million, so I am forecasting some growth over the next couple of quarters there.

In 2017 I am making what is probably a pretty optimistic forecast, with 20% growth in revenue and gross margins increasing to 35%. I’m doing this to get an idea of what Oclaro might be able to generate if things go well. I suspect that the 40 cents of EPS that I estimate would lead to a share price in the $8 range, maybe higher if growth is expected to continue to be strong.

Health Insurance Innovations

I sold some of my Health Insurance Innovations position. Not a lot, but enough to reduce my risk if something goes wrong. I got this across my google alerts and while I don’t know what to make of it, it doesn’t sound positive.

Arkansas News Bureau

LITTLE ROCK — State Insurance Commissioner Allen Kerr said Monday he has issued a cease-and-desist order against a Florida-based company over allegations it has used deceptive practices to try to sell short-term health insurance plans in Arkansas.

Kerr also released a list of tips for avoiding falling prey to dishonest telemarketers trying to sell health insurance plans.

The cease-and-desist order directs Health Plan Intermediaries Holdings, doing business as Health Insurance Innovations, to stop immediately the sale, solicitation or advertising of any insurance plans using unlicensed agents and to stop intentionally misrepresenting the terms of contracts or applications.

Kerr said in a news release that in a phone call with Insurance Department investigators, a Health Insurance Innovations employee offered insurance plans and gave price quotes despite admitting he was not a licensed insurance agent. Also, several company representatives falsely told investigators that two short-term plans, HealtheFlex and Principal Advantage Plan, were in compliance with the federal Affordable Care Act, according to Kerr.

I don’t really know what to make of this news. It’s probably nothing. Still, I felt a little better with a little less exposure to the name.

Radcom

A couple of data points occurred with Radcom in the past month.

First of all Netscout did a call on the NFV market and their service assurance offering. The call was broken into two segments, with the first segment being the more interesting of the two.

In the first segment is an industry expert from Analysys Mason gave a pretty good overview of the NFV opportunity, its risks and why service providers are inevitably going to move towards an NFV solution. His projections for assurance seem a little light based on what I see so far from Radcom, but I guess we will see how that plays out shortly. The call is worth listening to in full.

Second, I listened to the Amdocs fourth quarter conference call. Amdocs gave lots of commentary around what they are doing with NFV and even provided some reference to how RDCM fits in. Here are the comments I note (I highlighted a couple comments in particular):

When speaking about who will be the winners in this new market:

we think that actually the early adopters would come and the disruptor will come from the small companies. There is a lot of startups in this field, and we believe that some of it will go to the tradition, Cisco or Ericsson and the like but a lot of it will go to smaller companies.

Speaking of carrier advantages of NFV and their role as consolidator:

You can imagine that if you have a network that is all software devices, if you want to accelerate capacity or to change features instead of sending a technician that go to the box and do something, you just tweak it on a control plane in the data center. It’s like managing a huge data center. So the bottom line is that the trend is absolutely there. The nets are trying to fight it as much as they can, we are the disruptor, there are very few others, definitely not in our scale. We believe we could be the integrator of small companies.

And in terms of which carriers are getting a head start on their deployment:

In terms of the geographic spread that you asked, AT&T is probably by far the most advanced company with its theory and its power line under the Domain 2.0. You see some activities in Singapore Telecom, in Bell Canada, in Vodafone Group.

…So in the next 12 months to 18 months, you will see the big guys making decisions, that is to say Bell Canada in Canada, AT&T and Verizon in the USA, Singapore Telecom in Asia, Telefônica probably, Vodafone, these are the guys that will make decision.

Finally, what Amdocs will and will not do:

We will not try to build a better virtualized probe than the people that I expect on this or virtualized– if you see packet core (50:39) or something like this, we would not. So we are mainly after the high-end NFV component and maybe some services and integration on the SDN.

Radcom hasn’t performed terribly well as the market has recovered. The stock has been essentially flat. But this isn’t unexpected. It’s still a $100 million dollar company that reported revenue of a little over $2 million last quarter. I don’t expect a significant move in the stock until it either reports some big numbers, announces another contract, or gets bought out. The problem is that the last two items are game-changing events, and you can’t predict if one of them is going to happen tomorrow or next year. So I wait patiently.